by Professor Nick Bosanquet, Consultant Director, Reform
I’ve never known any business that does not claim to follow the ‘hockey stick’ pattern of earnings… This immediately shows some modest dip in earnings in the immediate future followed by continual improvement stretching to infinity (John Harvey-Jones, 1988).
Last week’s Pre-Budget Report was rightly exposed for its failure to address the budget deficit. The PBR not only failed to timetable a plan to tackle the deficit, but was also guilty of presenting hugely over-optimistic forecasts for the economy. Just when most companies in the private sector have got off the hockey field, with intense scrutiny forcing them to make realistic projections of their sales and revenues, the Treasury has moved in with a classic in hockey stick projections. This is shown in their projections for UK GDP for 2011 and 2012.
For 2010 the forecast for GDP growth appears realistic at 1 to 1.5 per cent. For 2011 the plans to reduce the deficit mean that public expenditure reduces growth by 1 per cent, but private consumption (+2), investment (+1), inventories (+½), net trade (+½) and dwellings investment (+¼) all raise GDP. Overall GDP is expected to grow by 3¼ to 3¾ per cent. But how reasonable do these projections look?
In relation to private consumption, from 2000 to 2007 this consumption contributed an average of 1¾ per cent to GDP .This was helped along by housing equity release and by heavy unsecured borrowing on credit cards. The Treasury projections imply that this consumption for 2011-12 is going to spring back to a growth rate even higher than in the boom years, although the conditions facing households appear to be radically different:
• the projections assume that a diminished number of households still in the labour force will embark on a major boost in consumption just at a time of pay freeze and, probably, contraction in the public sector workforce
• the projections need to be revised for high unemployment and rates of labour force withdrawal
• the projections also need to be revised for households increasingly saving rather than spending more of their incomes. As the Bank of England has shown, there are reasons to expect the saving rate to continue to be strong for some time, with some households, for example, beginning to register a further need for saving to provide an adequate income in retirement.
In relation to investment, the Treasury projections also expect a bounce in business investment, which is expected to contribute more to GDP growth than it did on average in 2000-07. However, there is evidence that corporate change is pulling investment in manufacturing and financial services towards the relatively high growth rates in Asia. There is also a pull for consumer products towards new Europe, where much food processing and component manufacturing is now heading.
As well as losing out from a changing distribution of investment, the UK also stands to lose out from any shifts towards investment protectionism. As OECD Secretary General Angel Gurria put it: “Investment protectionism poses a grave risk to recovery by further reducing international investment flows just at a time when these are most needed, ” with international mergers and acquisitions showing their largest year-on-year decline in recent history. The effect of this investment decline may take several years to become apparent, particularly given the short term stimulus from the car scrappage, but is nonetheless a real concern.
In relation to inventory, the projections show a perhaps too high contribution from this variable. In 2010 inventory change is expected to produce to contribute half (3/4 per cent) to the expected growth in GDP, followed by a further build up of inventories in 2011. This seems ambitious given the difficulties firms are facing in building up inventories at a time of constricted bank lending.
The Prime Minister in a recent interview defended these optimistic forecasts on the grounds that the growth in output would not be as constrained by inflation as in previous recessions. However, both households and companies can expect significant cost increases from increased taxes, including national insurance and council tax, and from higher prices to pay for carbon reduction. It is also not clear how long interest rates can remain low for, with the policy mix raising a serious risk of a housing bubble in 2011-12.
There are serious risks that the economy will not have the dramatic rebound projected for 2011 and 2012. What this reveals is that the economy will not be able to rebound fast enough to close the gap, even under the best conditions. As recent posts on ConservativeHome have argued, attempts to stimulate additional growth should be a priority for any future Government. However, only real cuts in public spending and genuine reform can close the deficit and move to an economy of growth. It is time that the Treasury got off the hockey field.
